Proxy fights take on new meaning

Canadian proxy battles cheap alternative to higher cost control battles

The bruising proxy battle earlier this year between shareholder activist Bill Ackman and Canadian Pacific Railway Ltd. for control of the company’s board cost a staggering $32-million.

While that’s a big figure for proxy fights in Canada, it’s chump change, compared with what Mr. Ackman and his company Pershing Square Capital Management LP would have paid in a takeover fight for control of Canada’s second-largest railway.

With a market cap last September of about $8-billion, a takeover would have been a costly venture to finance and shareholders would have expected a sizable premium.

Proxy fights are a cheap way to get control, but you don’t own the company

Instead, Mr. Ackman, CP’s largest investor, spent $15-million to win the proxy battle, which effectively gave him control of the board and the ability to appoint a management team favourable to his position. CP spent $17.5-million defending the fight.

It has paid off handsomely for Mr. Ackman. CPs shares are trading at historic highs of more than $81 compared with a low of just over $46 a year ago. Its market cap has risen to almost $14-billion, making CP shareholders wealthier in the long run.

“Proxy fights are a cheap way to get control, but you don’t own the company,” said Stuart Morrow, a securities lawyer in Vancouver at Davis LLP.

Is it any wonder, then, that proxy fights are taking on a new meaning in Canada? Why launch a hostile takeover with a premium, when the easier solution might be to ambush a company that is sitting on a pile of cash and take out an unsuspecting board?

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More and more companies in Canada are feeling the heat from proxy battles. It’s too early to say they have become the new M&A; however, they are having an impact, lawyers say.

“There is no doubt that in Canada this year, proxy contests are much more visible than they have ever been,” Toronto mergers and acquisitions lawyer Kevin Thomson of Davies Ward Phillips & Vineberg, the law firm that acted for Pershing Square in the CP dustup, said in an interview.

Proxy battles are being launched for a variety of reasons, ranging from full-scale assaults by unhappy shareholders looking to take over entire boards to skirmishes involving shareholders who simply want to secure a few board seats and force management to change course and divest assets or pay a bigger dividend. “Activist investors are more active than they have historically ever been,” Mr. Thomson said.

Bill Orr, a governance lawyer at Fasken Martineau DuMoulin LLP in Toronto, which represented the CP board, said, “There are an awful lot of boards of directors of fairly large companies looking at themselves closely and asking, ‘Could something like that happen to us?’…Nobody is immune.”

In a typical year, there are 15 to 20 proxy fights in Canada lawyers say, but this year that number has hit 25 and counting.

According to Aaron Atkinson, a Fasken lawyer, over the last five years, dissident shareholders who launched proxy fights “achieved some or all of their objectives 57% of the time.”

Atkinson attributes the rise in proxy fights to a variety of factors. “Sluggish banks are less inclined to lend,” he said, which is impacting leveraged buyouts. Stagnant stock markets mean shares are lagging and investors are demanding stronger returns.

“One way for activist shareholders to drive returns is to find opportunity in companies that are underperforming and achieve a turnaround without having to pay a premium,” Atkinson said.

Glenn Keeling, managing director at CST Phoenix Advisors in Toronto, which advises companies about proxy fights, called them a “ticking time bomb waiting to go off. We’re going to see an awful lot more concerned shareholders seeking seats on boards to effect change.”

Companies with market capitalizations under $500 million are most vulnerable, he said. Their boards are “substantially entrenched” and have “never really been on the radar screen. They are very, very resistant to change.” Boards, he added, have “never really been accountable like they’re having to be accountable now.”

Sharon Geraghty, a corporate lawyer at Torys in Toronto, said one factor to the rise in proxy activity is that “there is a number of large financial institutions prepared to get involved in these things now.” Pension funds such as the Ontario Teachers’ Pension Plan and the Canada Pension Plan, which both backed Ackman, are getting more aggressive with underperforming boards. “The likelihood of a Canadian [board] stiff-arming an activist is declining.”

As well, she said, investors in other countries are waking up to the fact that Canadian boards and companies have “fewer tools to stop activists. It’s easier to withstand this kind of charge in the U.S. There are more tools at hand.”

In the U.S., boards have the ability to “just say no,” and the election of directors is staggered, which makes it difficult for activist shareholders to clean house in one fell swoop.

However, in Canada, that’s not the case. ‘Under Canadian law it is much easier to attack a Canadian board,” said Thomson, of Davies Ward. “Canadian corporate statues have very limited protections for a board.”

Success, he said, depends on the “shareholder makeup” and “investor satisfaction or dissatisfaction.”

Thomson described a typical way an active shareholder takes over a board. A shareholder is allowed to solicit up to 15 shareholders prior to a vote and there’s no requirement to disclose that action. Shortly before the proxy cutoff date for the meeting to elect directors — at which point it’s difficult for the company to fight back — the activist files documents allowing that person to vote the shares he or she has solicited and provides the company with 48 hours’ notice that he or she intends to show up and vote those shares. During the meeting, the company is required to put forward its slate of directors and ask if there are any other nominations. The activist then puts forward a slate of directors backed by the votes he or she received. If the activist has enough votes, then it’s over for the existing board.

An activist might also go public early and foment discontent, proposing his or her own short slate of directors. At that point boards can appease by agreeing to some type of truce.

Another soft spot that activists are leveraging is majority-voting policies. Directors who receive 50% plus one of withheld votes must tender their resignation and let the board decide to accept it. Activists target certain directors, often those responsible for setting executive compensation, in a bid to get shareholders to withhold enough votes to force a resignation. That sends directors a strong message that they might be next.

Morrow of Davis LLP notes that companies are responding by creating defences to shut down potential proxy fights. In a recent ruling, the B.C. Supreme Court upheld an “advance notice bylaw” issued by the board in Mundoro Capital, which set a deadline for shareholders to put forward their director nominees.

Morrow noted that the TSX is also considering the “just say no” policy for Canada to give boards more tools to fight back against activists. He said it could be undemocratic for a small group of shareholders to ambush a board.

So how is all of this proxy activity impacting current M&A?

Stephen Halperin, a securities lawyer at Goodmans LLP in Toronto, said that a proxy fight is “very often the first step towards an M&A transaction. Activist shareholders act as a “catalyst for unlocking value.”

So a grumpy shareholder with clout can persuade a board to sell-off divisions or possibly even buy assets, which spurs M&A activity.

However, the proxy threat might also be causing some paralysis in the M&A markets, Thomson speculated. A board may want to buy another company, but must issue shares to do so.

Stock market rules require a transaction that dilutes shares by 25% or more to be put to a vote of the shareholders. “Putting that transaction to a vote could put your [company] in play,” he said, noting that’s what happened to Equinox Minerals Ltd. It tried to buy another company and quickly became prey of Barrick Gold.

Chris Makuch, vice president of sales and marketing at proxy solicitation firm Georgeson in Toronto, said when it comes to proxy fights, companies have to tread carefully. “People are usually looking forward. Don’t forget to look behind you. Once the play starts, it seems to me more often than not it’s going the distance. It may not be the same outcome that starts, but it rarely falls apart [or stops.]”